Monthly review and performance
Sentiment deteriorated in August, despite a strong start to the month. Spreads on EUR IG credit widened by 15 basis points (bps) to around 200 bps, edging closer to year-to-date wides of around 220 bps. Central banks were in focus this month, as early relief from better-than-expected US CPI numbers was met with a hawkish narrative on both sides of the pond, emphasising a firm commitment to tackle inflation. Uncertainty around growth continued to weigh on sentiment, as a result of both softer macro data in the US and soaring gas prices ahead of a tough winter. Heavy issuance also impacted sentiment, as issuers front-loaded supply, hedging some macro uncertainty. Despite weak sentiment, the surge in rates has been the key driver of returns over the month, as EUR IG returned -4.2% over the month after a record positive +4.7% total return in July. Interestingly, three of the 10 worst months for IG credit occurred in 2022. Hawkish central bank commentary led to aggressive rises in rates and a +0.7% rise in the 10-year bund to +1.5%, the second largest absolute monthly move on record.
Supply was unusually elevated in August, as issuers jumped the gun earlier than usual into the summer, frontloading some issuance needs given ongoing uncertainty. Green bonds from financials were no exception, with EUR 7.2 billion of supply compared to EUR 0.4 billion in July and an average of EUR 0.5 billion in August (2019-2020). August was also particularly rich in terms of subordinated debt supply, with close to EUR 2 billion of new Tier 2 in green format, from the banking and insurance sectors. Given the market volatility during the month, deals came with significant pricing concessions and at very attractive levels given overall levels of spreads and yields. For example, NN Group, the Dutch insurer, issued their first green bond – a EUR-denominated fixed to floating Tier 2 maturing in 2043 with a first call date in 2032 – at a yield of 5.3% (more than 410 bps above government bond yields). The bond is IG-rated (BBB- / BBB+ by S&P/Fitch), and offers more than double the spread on EUR IG credit – reflecting the attractiveness of subordinated debt. Even in senior format, NatWest Group issued a EUR green bond at close to 4.1% yield and 285 bps of spread, compared to 200 bps of spread on EUR IG corporates, despite similar ratings and lower duration.
Second quarter results continued on strong footing, as financials benefit from higher rates while capital and asset quality remain robust. As an example, HSBC’s net interest income is expected to be at least USD 37 billion in 2023, more than USD 10 billion or 40% above 2021 levels – boosted by higher rates. Analysts expect the bank to deliver a 10%+ return on equity by 2023, double the average of the past three years. For bondholders this means over USD 25 billion in annual pre-tax profits to absorb any potential rise in loan loss provisions from deteriorating macro uncertainty. On the insurance side, solvency positions benefitted strongly from higher rates, for example Uniqa’s solvency ratio improved by 38 points to 234% and Munich Re’s Solvency II ratio improved by 25 points to 252% since the end of 2021. Financials are uniquely positioned in the current scenario of higher rates – we see the sector as the sweet spot in a highly uncertain environment. Even in a worst case scenario, we believe that financials could absorb the impact of a macro shock through earnings alone, leaving excess capital unscathed. Our latest article provides some further detail on the resilience of the banking sector in the face of a recession (Banks: Resilient in the face of recession | GAM).
Valuations remain extremely attractive, fully disconnected from fundamentals of financials that would remain strong even in a weak scenario – as demonstrated by second quarter results. With a yield (to next call) of 4.7% and an average spread (g-spread) of around 305 bps on the fund (compared to 3.4% / around 200 bps for the EUR IG corporate market), we see this as a unique opportunity to capture high income with upside potential from tightening spreads. This is despite the high quality bias of the fund (average bond rating of BBB+ / average issuer rating of A) and lower duration compared to the EUR IG corporates (4.3 years versus 4.7 years).
Project corner : CNP Assurances SA
- Project type: Forestry
- Location: Scotland
- Project owner: CNP (direct ownership for the group’s investment portfolio)
- Investment amount: EUR 9.6 million
- Surface: 819 hectares
- Environmental certifications: PEFC-certified
- Net annual volume sequestered: 1,636 tons of CO2
- CNP’s green bond is 50% finance and 50% refinance. However, of the 50% refinance, most of the projects were under construction at time of issuance – reflecting the additionality of the impact
CNP’s sustainability strategy highlights
- Net zero commitment by 2050 including the group’s investment portfolio
- 2025 science-based targets to reduce the carbon footprint of its direct equity and corporate bond portfolio by 25%, real estate footprint by 10%
- Targets based on recognised scenarios and methodologies (International Panel on Climate Change (IPCC) 1.5 degrees pathway, Carbon Risk Real Estate Monitor 1.5 degrees pathway)